Spotlight interview with Navin Chaddha Part 1: Mission first, money second. The value of relationships in venture capital.

Each spring in Silicon Valley, a minting of sorts takes place. No money changes hands, though the transaction may be worth its weight in gold.

The annual release of the Forbes' Midas List has been known to send shockwaves through the halls of the world's leading venture capital firms. These investment mainstays may not all be as fast-talking, tequila swigging, or Lamborghini revving as startup stereotypes may suggest.

Navin Chaddha is about as close as you could get to a permanent resident though. Calm, polite, and measured, the Mayfield Fund managing director has been included on Forbes’s list 14 times since its debut in 2001. His most recent inclusion comes in the wake of his firm's gangbusters positions in unicorns like Lyft and Poshmark, and according to this year’s run down, he’s clocking in as the world's fifth most celebrated venture capitalist.

As a serial entrepreneur, Chaddha has worked on both sides of the investment aisle. He sold his first company to Microsoft in the 1990s, and he had the chance to work closely alongside Satya Nadella, now the software giant's CEO. From his home in northern California, Chaddha discusses how investors should go about tracking deal flow, the inescapable importance of relationship management, and drumming up repeat business with the same entrepreneurs time and again.

(This interview has been edited and condensed for clarity.)

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Affinity: We’ll get to a few items about your career, managing deal flow, and the value of relationship building in investing soon, but it might be missing the mark here to begin anywhere else. You’ve been a VC through two downturns, most notably in 2008. Where do you see us heading economically now, especially regarding venture capital and the investing community?

Chaddha: Venture capital and startups are about running a marathon, not a sprint. You have to take a long view of anything and everything you do in early-stage investing. 

I believe great companies are created during tough economic downturns, like the one we’re in now. If you're going to fund a company right now, you have to take an eight- to 10-year outlook. If you're a mid- or late-stage company or a public company you have to just weather the storm. 

But I think it's a great time for startup founders to think about starting a company because big companies won't innovate. The amount of venture capital that will get invested into companies will only go down. So there'll be less competition, fewer dollars. Big companies won't invest. It's a great time to start a company and take the long view.

Affinity: How does the behavior of venture capital at a large change in uncertain economic times?

Chaddha: As far as the venture capital industry is concerned, over the last three to four years— especially early in the COVID-19 pandemic—[it] got overcapitalized. A lot more money was invested yearly in private startups, and that won't be the case [going forward]. The amount of funding invested every year in venture-backed private companies will go down. And most VCs are going to take one of a few approaches. 

Some VCs might decide to be pencils up, wait for the markets to get better, and just focus on their existing portfolios. Another set of VCs can get aggressive in this environment, which Mayfield is doing by being pencils down. We know that the innovation cycle is here. Great companies are created during tough times. So we’re going to get active.

Most [investors] will be in the middle. They'll be cautiously optimistic.

Affinity: It’s said that venture growth often occurs in times when the economy is in rebound. We’re coming out of a pandemic, which could signal a recovery. But we’re also entering, or have entered, what appears to be a recession. 

So what's the truth here? Is a rebound upon us now in venture capital, or is it not likely to come until this recession begins to ease after one year, two years, whatever it is?

Chaddha: The COVID pandemic was, for venture capital, a V-shape recovery. Technology ended up being the savior of the economy because everything went online. [In-person] work stopped, stores shut down. Online, remote work, and eCommerce were the savior of the economy—and the world in general.

“...you're making a bet on the people. Fundamentally, you're not betting on a product. You're making the bet that people build companies and make products. Not the other way around.”

Technology became the must-have, and technology companies thrived. As a result, the amount of money coming into venture capital doubled. And once the pandemic started normalizing, you saw the retail economy open up and people return to work. As a result, we’re seeing the amount of venture capital going down. 

So I don't see today as a rebound. It's normalization. Getting back to where things were before the pandemic. That's where we will end up—in a steady state. Venture capital grows at 5%, 10% a year in a steady state. If you take out 2020 and 2021 and look back at what was happening in 2018 and 2019, you'll see a slight uptick. The data will normalize, but it will be down from what happened last year.

Affinity: In terms of how it will impact venture capital, do you see any similarities between right now and the recessions of the early 2000s or 2008?

Chaddha: 2008 was not as severe for the tech industry. It was primarily a financial services industry crisis. In general, Silicon Valley and the tech community weren't impacted as much as they were in '99 and 2000. 

Right now, I would say things are still uncertain. People are talking about whether or not we’re in a recession. We probably are. But the key thing is: Technology spend hasn't been impacted as much [yet]. That's still to come. Because if you look at what people are doing—[ companies are] adjusting earnings, missing earnings. Consumer sentiment is low. As you see with Walmart, Target—advertising spend is down. Microsoft has reforecasted its outlook.

To me, the [current economy's] effect on tech is [already] baked in the price of public companies, but it's still not come into the private world. But if companies are on a hiring freeze, next they’ll look at their CapEx (capital expenditure) and software spend and choose which of them is a must-have versus a nice-to-have tool. 

They’ll ask if they can delay a purchase or push it to next year. Those conversations are happening in all organizations now, so we’ll see the trickle-down effect of what happened in public markets come to the private markets.

Affinity: Tech stocks, as you suggested, are getting hammered in the public markets. But you're saying the prices of investments in private tech companies haven't been nearly so hard hit yet … 

Chaddha: The effect of this post-pandemic, recessionary environment—with high inflation and high-interest rates—is already baked into [public stock prices]. We’ll probably see a 10%-20% downward movement in the tech world. But this effect is still to come to private markets.

Public market companies—which went public with, say, $100-, $200-, $300-, or $ 400 million in revenues—are probably at half to one-third of their peak valuations. We haven't seen that happen yet in private markets, which will still have to go through the [same] adjustment. Usually, it takes a year for that to happen, and we’re only six months into that.

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Because it's long cycles, right? If I look at, year-on-year, our valuations [of companies my team’s invested in], are they half? No. Are they one-third? No way. It takes time. And private markets, besides late-stage [companies], may not adjust as much to the effects of the public markets. But valuations, in general, will reach the normal state they were in 2018 and '19, which were still high, but they're not going to be at the pandemic levels. 

If you look at a median software company, in the pandemic, it was trading at like 15X [its] next 12-month revenues. There were top-five software companies [trading] 50X next 12-month revenues. I think the median, as of 31 July, was around 6.7X next 12-month sales. 

Is it the bottom? Who knows? During '08 and '09, that multiple had fallen to 3.5X to 4X [next 12-month revenues], but markets are much more significant today. Companies have scaled. They have more predictability. So it's a different era.

Affinity: We talked about private markets. We talked about public markets. And we talked about them in separate terms. But there is an instance when these two join in some ways, which is when a company IPOs.

During a recession or a period of economic uncertainty, do you see companies you invest in becoming more reticent to go public during a time like this? Does that delay the process for them? 

Chaddha: It delays the process. If you're building a great company, money will [always] be available in private or public markets. The key question is: When the public market headwinds are not moving in the right direction, do you really want the headache of being a public company? Because private capital will still be available.

“So I don't see today as a rebound. It's normalization. Getting back to where things were before the pandemic.”

For public markets, you do an IPO because it's financing plus a liquidity event for shareholders. But I think a lot of companies that could [go] public are just going to wait because nobody wants to go through this turbulent environment where their multiples are being hit across the board. IPO bankers are telling companies to just wait it out.

That's a macroeconomic and a sector view. It's not zoomed in on an individual stock or an individual company. Companies are just going to wait because once the volatility goes away they can still go public and raise money. But there's enough money in the private markets for companies to still get financed. 

Again, one has to take a long view. But right now, the IPO window is shut.

Affinity: You’ve said, “Let's invest in relationships, not transactions.” I read in Harvard Business Review that nearly 70% of deals a VC does come from existing connections within their professional networks. How do you measure the value of relationship building as a venture capitalist?

Chaddha: As I mentioned earlier, company building is a marathon. So being a venture capitalist, especially at Mayfield, where we invest at the inception stage or the idea stage of a company, you're making a bet on the people. Fundamentally, you're not betting on a product. You're making the bet that people build companies and make products. Not the other way around.

And if you get that straight you're removing execution risk. From there, the only risk you're taking is whether the market [that] the company [says it] is going to create happens or not. Or, if it's an existing market [the company is entering], the team can execute and create a 10X better product, [and then] the sky's the limit on the opportunity for the company. So that's one [way to measure value]. 

“We’re backing companies that are going to change the world. We’re helping entrepreneurs who are going to change the world. If they change the world, money will get made.”

Second: It is important to focus on relationships because if you look at an entrepreneur—being an entrepreneur, a CEO, or a founder is a lonely journey. Sometimes you're a solo founder.

Sometimes you have a couple of founders with you. And the odds are against you, right? Because you have less money than public companies. Recruiting is hard. Selling is hard. Why should I buy from a startup? 

So why not be their sounding board, their safety net, and give them that zone of comfort. Let them know that through the ups and downs of their company they're planning to build, there will be an investor, a board member, who can be the shock absorber or the safety net if they fall. Rather than always measuring [against] them, the board member or their lead VC is there for support and to help them succeed.

My belief is if you can get people and entrepreneurs as a VC to work at the peak of Maslow's hierarchy [of needs], where they know they're secure, basic needs are met, they're loved, there's food, there's shelter—then they can perform at the highest level. So that's the basic outlook I have. It's pretty intuitive, and it's common sense.

Affinity: Is it an oversimplification to say that an X% return on your capital is your number one marker of a successful investment?

Chaddha: For me, I look at my job as a VC as twofold. First and foremost, we have to partner with entrepreneurs whose companies can change how people work, live, and play. And if they can do that, a lot of return is possible. 

So, to me, you need to focus on the mission of changing the world, and that's going to produce the returns. You can't [prioritize] returns first because that’s late-stage and public market investing. Here [in early-stage private market investing], you need to be more mission-oriented. We’re backing companies that are going to change the world. We’re helping entrepreneurs who are going to change the world. If they change the world, money will get made.

Mission first. Money second.

Read part 2 of our interview with Navin now.

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